How to Evaluate Mobile Home Park Investments for Profitability

If you read my last BiggerPockets Blog article “Will Mobile Home Parks Be the Hottest Real Estate Investment of 2020?,” you’re probably thinking, “OK, I get it. This mobile home park gig seems to be totally worthwhile. But how do I profit in the space with all the recent market and industry changes?”

Good thing you’re here reading this, as the purpose of this article is to teach you exactly that.

You may also be wondering, “If there is more competition than ever in the mobile home park (MHP) space, why are you about to tell us how we can best profit given the current market conditions?”

As I’ve mentioned before, the answer is simple:

I see it as my ethical obligation as a mobile home park investing educator to help point out some of the main ways new MHP investors can minimize pitfalls and maximize profits.
I truly believe we live in a world of abundance, and there are more than enough MHPs for us to all profit from. In all reality, I can be screaming from the treetops and not everyone is going to pursue financial freedom or become a mobile home park investor. I wish financial freedom and living a freedom lifestyle for all of us. Yet some of us are too busy keeping up with the latest sports scores or our favorite TV series on Netflix to take the necessary actions to achieve it. (Clearly, YOU understand the importance of financial freedom. You’re dedicating time to reading this article.)
I don’t want new MHP investors to incorrectly evaluate and overpay for MHPs, as this will artificially drive up MHP purchase prices and further compress cap rates, making it harder for MHP deals to pencil out.

Regarding my latter point, I’ve already seen this happen in the MHP space. Newbies have come in un-educated or using evaluation methods from other asset classes, then overpaid and under-performed only to bring those same parks back on the market after losing their hard-earned $$$. Then they expect buyers to pay unreasonable prices to reduce the pain of their loss.

To completely eliminate that from happening is impossible. Yet if you are reading this and you’re wanting to break into the MHP space, I’m glad you will get to know some important ins and outs of profitability before you take on your first or next park.

If you read my previous post, you understand the MHP space on at least a slightly deeper level. (If you didn’t read it, I recommend you start there.)

Now that you’re familiar with the basics of this asset class, let’s dig into how you can navigate profitable mobile home park investments in today’s market. As times and circumstances change, we too need to move with—or even better, stay ahead of—the game. The same old tricks that used to work prior to 2018 do not apply today.

Let’s start off with how we can best avoid pitfalls.

Dos and Don’ts of Evaluating Mobile Home Parks

DO: Use the Correct Evaluation Method

First, and most importantly, do NOT use evaluation methods from other asset classes and think they will successfully transfer to profitable mobile home park investing.

I see this way too often in today’s market where successful self-storage and apartment investors who have been crushing it in those asset classes jump ship, switching to mobile home park investing while using the same evaluation method that they did for their previous asset class.

It is true that much of the general or overall style of investment or ways to manage investments can be similar (especially when compared to self-storage or apartments), yet there are a few main points to look out for when buying and managing a mobile home park.

DON’T: Apply Cap Rate to Mobile Home Rent

In MHPs, there is always “lot rent” that gets charged to a tenant—regardless of whether they own their home or not. That’s the fee tenants pay to the park owner for essentially parking their home on the land and using the available utilities.

In addition, a tenant who does not own their home (aka lives in a park-owned home, or POH) has to pay “home rent” in addition to lot rent.

When buying a park, we do need to give value to POHs. It’s just that we add the value of the homes AFTER we establish the value of the land first. If we incorrectly add home rent to our land value calculation, then apply a cap rate to it, we artificially drive up the purchase price of any given park, which means we overpay and consequently decrease the spread or potential profits left in the deal.

Do NOT apply a cap rate to mobile home rent when evaluating a mobile home park. I can’t drive this home enough. The mistake of capping home rent income could literally turn an otherwise profitable deal into a mediocre deal—or even worse, a significant financial loss to the buyer.

It’s commonly said that in real estate, “You make money when you buy, and you receive that money when you sell.” This rule also applies to mobile home parks. There is no quicker path to mobile home park failure than by incorrectly evaluating your purchase price and overpaying.

How to Evaluate a Mobile Home Park

Here are a few general rules of thumb.

Step #1: Land Value Formula

Take the average monthly lot rent—do not include home rent—and multiple that by the number of occupied, paying lots. Do not include delinquent lots. Multiply that by 12 months to annualize the figure.

Then, take that figure and multiply it by your operating income ratio. To do so, convert your operating income ration percentage into a decimal form. For example, 40 percent operating expenses would equate to 60 percent operating income, which is displayed as 0.6.

Divide that by your cap rate. If your cap rate is 8 percent, you’d divide by .08.

This calculation results in your land value (before any necessary immediate repairs).

Average Monthly Lot Rent X Paying Lots X 12 Months X Operating Income Ratio / Cap Rate = Land Value

Example: $300 Lot Rent X 56 Paying Lots X 12 Months X 0.6 Operating Income / .08 Cap Rate = $1,512,000 Land Value

Step #2: Subtract Immediate Infrastructure Repairs

Now we know the land value before immediate repairs. But what if something needs to be done to the infrastructure in the first 12 months of ownership?

Well, in that case, we need to subtract that from the land value. When we own a mobile home park, for the most part, we are responsible for maintaining roads and underground water and sewer lines. Additionally, if we own private utility systems—like septic, water well, gas, or electric—then we too are responsible for the maintenance of those systems.

This can be an expensive game to play. Repairing roads or sewer lines can cost tens or hundreds of thousands. Repairing private utility systems can cost upwards of a million dollars. Given these high price points, it’s imperative that we evaluate the likely dollar amount of repairs needed to the park’s infrastructure in the first 12 months of ownership and subtract that off land value.

If, for example, we found out that we had $100,000 in anticipated road repairs and $27,000 in anticipated sewer line repairs (because we followed our four-stage mobile home park investing due diligence plan, as wise investors do), then our evaluation would look like this:

Example: $1,512,000 Land Value – ($100,000 Road Repairs + $27,000 Sewer Line Repairs) = $1,385,000 Land Value with Immediate Repairs Included

Cool, so we got that far. But what if some of the tenants are paying mobile home rent for park-owned homes? That has to have some value, doesn’t it?

Yes. It’s just that we don’t want to apply a cap rate to that number.

Instead, we find the market value of all the park-owned homes and pay 70-80 percent of that market value, as we are buying all the homes in bulk and deserve a sound discount.

Say a park has 56 lots, and 10 of those lots have park-owned homes (which means 46 lots have tenant-owned homes). Then we need to look at the market value of these 10 park-owned homes and only apply 70-80 percent of value to them. For this example, we will use 80 percent.

Example: 10 Park-Owned Homes X $12,000 Market Value = $120,000

$120,000 X 0.8 = $96,000 Park-Owned Home Inventory Value

Now we need to add the park-owned home inventory value to the land value amount to give the true value of the mobile home park.

Example: $1,385,000 Land Value with Immediate Repairs Included + $96,000 Park-Owned Home Inventory Value = $1,481,000 True Value

At this point, you’re a wise MHP purchase price evaluator!

But let’s look at that evaluation again for good measure.

Land Value – Immediate Infrastructure Repairs + 80% of Market Value of the Park-Owned Home Inventory = Purchase Price

You’ve got it. Great!

Now let’s talk about how applying a cap rate to POH rent can falsely inflate the purchase price value.

What If I DO Apply Cap Rate to Home Rent?

Let’s say mobile home rent is $250 a month on top of lot rent for tenants who are in a park-owned home. We applied a cap rate to it. In that case, instead of giving our park-owned home inventory a value of $96,000 (like above), it would look like this:

Example: $250 Home Rent X 10 Park-Owned Homes X 12 Months X 0.6 Operating Income / .08 Cap Rate = $225,000 Park-Owned Home Inventory Value

Again this calculation is if based off home rent with cap rate applied.

How Much Money Would We Lose If We Made That Mistake?

Here’s how much you could have overpaid for this park.

Example: $225,000 – $96,000 = $129,000

Said differently, you paid 2.34 times the actual value of the homes.

Imagine if home rents were $400 a month or you had 56 park-owned homes. That would not only eat up much of your potential profits, it also may leave you in the negative.

More Dos and Don’ts of Mobile Home Park Investing

DO: Make Sure to Correctly Evaluate the Risk of Private Utilities

In the MHP space, it’s common to see parks with private utilities. It’s subjective whether to buy a park with private utilities or not due to the risk and management involved in owning private utility systems. This is something you are going to have to weigh the pros and cons of yourself.

I personally am OK taking on private utilities—as long as I have correctly evaluated their risk cost and reduced that cost from my purchase price. (This falls under the “immediate infrastructure repairs” part of our calculation above.) Nonetheless, if you are considering buying a park with private utilities, you need to correctly evaluate the risk of each system.

If you don’t own private utilities, then you are a glorified parking lot. You only need to maintain underground water and sewer lines and roads. If you are extra lucky, then the city may own and maintain the roads, although that’s a less likely scenario.

On the other hand, if you own private utilities, then you become a glorified utility company. Along with that comes extra management, compliance, and increased liability—and that’s just on the billing side of things. Additionally, if you own private systems, then the park’s responsible if those systems fail or need repair. Consequently, the park is responsible for replacement utilities in the interim. This can cost the park owner tens or hundreds of thousands—or even millions—if you have certain private utilities.

Therefore, when performing due diligence before purchase, make sure to have each system fully evaluated by licensed contractors for best-case, worst-case, and probable-case scenarios.

If your worst-case scenario is potentially being responsible for $100,000 to repair an electrical system, then how will that affect your overall profits? Would it be a deal-killer?

What if the probable case is $30,000 of repairs? Will that kill your annual cash flow for that year? Or would it only make a slight dent in your cash flow?

Either way, each case is specific to the park and systems you are buying, and proper evaluation is required to determine if you can handle the worst case and if you are comfortable if the probable case comes to fruition. Seem like this will kill the deal? Then it’s best to deduct some more off the purchase price to compensate for this risk as needed.

Let’s be real, many mobile home parks are 50-plus years old. Those private utility systems will fail at some point. Don’t buy a hot potato, unless you know you can handle it financially and mentally.

A Real-Life Mobile Home Park Private Utilities Disaster

I had a park in California where we owned the gas system. One of the tenants called the gas provider late at night with concerns there was a gas leak. The gas company came out to inspect, and using their gas-sniffing apparatus, they detected a tiny gas leak the size of a pilot light.

As a result, the gas main was immediately shut off and locked out by the gas company. The entire park was left with no gas for stoves, hot water heaters, or furnaces. We were instructed to repair the leak, have it tested and inspected, and then get the gas turned back on.

Oh, and I forgot to mention, this happened in the dead of winter—when everyone needed these heat sources the most.

Not a biggie, though. It’s only as small as a pilot light, right?

Try pinpointing a pinhole leak in an underground gas system that’s somewhere in a 40-space park, while the gas is not turned on.

We found the general location and started digging until we could inspect the lines in that area. We found the leak and fixed it. The next step was to test the line to confirm no leaks were present.

The funny thing (not so funny for park owners) when testing a gas line repair is that code requires the system to undergo a pressure test. Seems reasonable. But they require we put twice the operating pressure in the system for good measure, which of course can lead to over-pressurizing the system and creating more leaks as a result.

Lucky for me (heavy sarcasm), that was the case. We caused further leaks, again the size of a pinhole, only to leave us playing the find, fix, and test game for two weeks until we finally solved the problem and got the gas back on.

In the meantime, our manager was running around the park day and night, doing her best to take care of everyone and keep them warm. We bought electric heaters, blankets, and electric cooktops for every home. We even purchased medications and supplies for families and hot meals for everyone in the park to compensate for this inconvenience in what seemed like at the time a neverending saga.

Don’t get me wrong, I like excitement. I’d just prefer to keep my surfing exciting and my mobile home park investing nice and boring.

Having that said, we’d evaluated this potential risk up front, we had an emergency plan in place, and we ended up coming out of that relatively unscathed—we were prepared. It was not so much a surprise as an “OK, here’s that thing we anticipated being a possibility. Let’s proceed as planned…”

Things could have gone worse. And we were ready if that were the case, too. Moral of the story: be a wise investor by anticipating and evaluating these utility system risk possibilities to makes sure you can handle them should they ever come to fruition.

DON’T: Fluff the Numbers

As you can see, there are quite a few numbers in the evaluation of a mobile home park. If you change one of these numbers, then the evaluated purchase price will change. If you change two or more of these numbers, then you can double or triple the evaluated purchase price.

Let’s take the evaluation we did above and change a few of the numbers so we can falsely validate paying for an overpriced park.

“Come on, I really want this park and I’m just trying to make the numbers work!”

Good job, you’re catching on to my sarcasm by now. Fluffing the numbers is a big no-no, and here’s why.

Say lot rent is $300, and you have 63 tenants. Fifty-six are paying and seven are delinquent, but you ignore this. You evaluate the park assuming 70 percent operating income, even though it’s 60 percent in all actuality. You also use a 7 percent cap rate, when realistically market is 8 percent. Here’s what you get from your (mis)calculation.

Example: $300 Lot Rent X 63 Tenants X 12 Months X 0.7 Operating Income / 0.7 Cap Rate = $2,268,000 Land Value Before Immediate Repairs

In the first and correct evaluation, we had a land value of $1,512,000. Yet now that we fluffed the numbers (only slightly), we came up with a new land value of $2,268,000. In that case, you’d be paying $756,000 more than needed.

Or, to look at it differently, losing $756,000 in future potential profits.

I get it. You want your first park badly—but don’t veer from the numbers. Numbers don’t lie. If you don’t buy right, then you won’t make worthwhile profits.

If in doubt, be conservative and err toward paying less for a park rather than trying to fluff the numbers to validate paying over. Your time and money are too valuable to waste or lose!

Proper Mobile Home Park Evaluation Summary

Don’t apply evaluation methods from other asset classes to mobile home parks.
Don’t apply cap rate to home rent.
Deduct immediate infrastructure repairs from land value.
Add on 80 percent of market value of park-owned homes to get purchase price.
Properly evaluate the risk of private utilities and adjust purchase price as necessary.
Know your market rents and market cap rates to make sure you’re not overpaying (How? Talk to brokers, other park managers, and tenants in the area to get the stats.)
If you are not 100 percent confident about your MHP evaluation, then be sure to get properly educated (or at least get an experienced MHP investor to double-check your evaluation).
You make money when you buy a park (correctly), and get paid that money when you sell.

You’re going to invest much of your hard-earned money and dedicate valuable time to each MHP investment. It’s typically a three- to seven-year commitment per park, so make sure you are making it all worth your while!

The Bottom Line

There are many ways to approach MHP purchase criteria. You may decide after reading this article that some of the things I’m down for, may not be a good fit for you (such as lower occupancy parks, high POH count). Nonetheless, these points are things to take into heavy consideration, and I hope you have found it valuable when looking toward your first or next MHP purchase or investment.

If this all sounds like too much work, this article may have helped you realize you’d rather be a passive investor and let someone else do all the heavy lifting. Alternatively, you may have thought of investing passively and now you’re “game on” to give active investing a crack.

Either way, I wish you all the utmost success as an MHP investor. Whichever path you chose, let me know how I can help you along the way.